Does the carbon market help or hurt the stock price of electricity companies? Further evidence from the European context

The electricity sector is the largest participant in the European Union Emissions Trading Scheme (EU-ETS). This paper studies how the European Union Allowance (EUA) market - the carbon market in the European Union (EU) - has impacted the magnitude and volatility of stock returns of electricity companies in the EU-ETS. The investigation is undertaken for both Phases I and II of the EU-ETS based on simple OLS, panel data and time-series analysis. The results indicate that the relationship between the EUA market and stock returns of electricity companies was largely driven by strong market shocks recorded in both periods. If the market shock impact is controlled, this relationship depends on the carbon intensity of the electricity generators. The stock returns of carbon-intensive companies are negatively affected by the EUA returns, while the opposite is true for less carbon-intensive producers. The volatility of stock returns of electricity companies is significantly driven in the same direction by the volatility of the EUA market.